Chinese banks indirectly at risk due to margin lending

Stock market volatility exposure was cited.

It has been noted that rapidly growing margin lending poses indirect risks to Chinese banks through their lending to trust and securities firms, and raises their exposure to stock market volatility.

According to a release from Fitch Ratings, however, the extent of margin lending remains small relative to the banking sector as a whole, and is unlikely to pose a significant risk to major institutions.

The aggregate margin lending balance at China's stock exchanges has almost doubled since end-2014 to CNY1.9trn (USD302bn), equating to 3.1% of domestic market capitalisation as of 8 May.

This has contributed in part to the rapid rise in China's A-share equity market, which has surged by more than 30% since the beginning of the year.

Chinese banks do not lend directly to investors to finance stock purchases, but they do lend to securities firms - which includes repurchase transactions with margin loan beneficiary rights as the underlying collateral.

Here's more from Fitch Ratings:

They also finance leveraged products issued by trust, fund management and securities firms. These transactions effectively constitute margin lending exposure by the banks, and funds for the transactions are typically raised through the sale of wealth-management products.

There is no official data on banks' margin lending exposure; though with banking system assets at CNY172trn (USD28trn) at end-2014, it is likely that the exposure is relatively small.

Nonetheless, growth in margin lending exposures suggests that the performance of the stock market could exert a greater impact on banks' credit profiles, especially for those banks which are more actively exposed. There will be a closer correlation between the asset quality of banks and the trust and securities firms.

Furthermore, bank profitability will be affected in the event of a sharp scale-back in margin lending due to reduced investor demand or regulatory tightening. Banks will also face heightened credit risk if non-margin lending is being mis-used and diverted to a rapidly rising stock market.

Fitch believes that the counterparty credit risk facing the banks should be fairly contained if margin requirements are sensibly set and adequately followed. This is especially the case as any margin lending loss would also be contingent on non-performance by the corresponding securities or trust firm.

However, the decision by the China Securities Regulatory Commission (CSRC) in 2015 to fine and suspend new account openings at a number of brokers for violations of margin lending rules, indicates that regulations are not strictly followed by market participants. It also highlights more broadly some of the risks related to corporate governance in the country's financial sector.

The CSRC is tightening regulations on margin lending further, having already raised investors' qualification criteria and halted participation in leveraged trust products by securities firms in 2015.

The central bank and banking regulator may place further restrictions on margin lending if they are concerned with potential risks to the banking system. Notably, the China Banking Regulatory Commission is gathering public comments on draft rules regarding entrusted loans, which prohibit the use of proceeds for stock investments. It may take similar action with regard to wealth-management products.